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Stuck and Nowhere to Go

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LiermanThe FOMC left the Fed Funds rate at the 0.00-0.25% range. In the statement the Fed strengthened their view on the economy and mentioned that the labor market is on a “solid” pace. Household purchasing power will get help from lower energy. The committee did point out that inflation is going to continue to drop moving them further away from their 2% target. Mr. Market focused on two key words in the third paragraph “international developments”. The FOMC added this in the wake of weak international economic readings. Up to this point the markets were more worried about what was happening across the pond than the FOMC. However, the committee has now publicly focused on it and it caught the market’s attention.

The 10 and 30 year bonds dropped in yield 5 and 6 basis points from the announcement to end of the day stopping at 1.72% and 2.29%, respectively. The S&P 500 dropped 1.57% after the news and finished the day at 2002, with a risk off feeling. These are rather big movements considering most of it was potentially priced into the market.

The FOMC was in a tough spot. The Bank of Canada on Jan 21st unexpectedly cut their overnight rate by 25 basis points. The ECB on 22nd announced €60bn per month in asset purchases which are intended to be carried out until end-September 2016. The Bank of England and Japan have QE asset purchases underway.

For years there has been a coordinated effort among the world central banks on monetary policy with the Fed leading the way. With the world economies becoming more uncorrelated and as the U.S. economy strengthens the Fed would like to break away from other central banks and get back to a normal policy.

The market can never be satisfied. Throughout 2013 and 2014 the market wanted QE to end and the Fed to start on a path of rate increases. Now the Fed is getting closer to lifting rates. By acknowledging foreign economic weakness the markets got spooked thinking the Fed will drag its heels on rate increases and fumble the monetary policy ball.

The Fed is stuck and nowhere to go but stand still. The committee will continue to be data dependent and monitor exogenous shocks, but it’s the US economic data that matters and if it continues to be positive with oil prices finding a floor look for the Fed to be at the launching pad in the 3rd quarter.

Bill Lierman, CFA®
Vice President, Portfolio Manager

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